How Many Big Macs Can The World Eat? -- Part II

In part I of this article, we talked about McDonald’s expansion opportunities and how it could easily add another 10,000 new restaurants in APEMA (Asia/Pacific, Middle East and Africa) in the next 6-7 years.

So, what are the reasons stopping McDonald’s from opening 1,600 or 2,000 stores annually as opposed to 800 it opened in 2011 – the highest in the last nine years? In 2012, the company plans to add around 900 new restaurants which again implies it has potential to open more.

McDonald’s prefers the franchisee model. Over 80% of its restaurants globally are franchised. However, it is not always easy to find franchisees that are on the same wavelength as McDonald’s. This is true especially in developing countries where the restaurant chain faces difficulties such as quality and reliability issues, a weak legal system, or simply that franchisees do not possess enough scale.

A paucity of good franchisees meant that the restaurant chain had to open company-operated stores in China since it obviously wanted to be part of the country’s growth story. Only 36 of its 1,400 restaurants were franchised at the end of 2011. Opening company-operated stores often requires a greater capital expenditure which could slow down the expansion process. There are other countries too such as Vietnam where McDonald’s doesn’t have a presence yet because the company has not been able to find the right franchisees.

2) Real estate dynamics

As much as McDonald’s is a fast food chain, it is also a real estate company. Usually, McDonald’s owns the land on which its franchisees operate. The company then collects a one-time initial fees, rent and royalties (which are a percentage of sales) from the franchisees. These franchisees are labeled conventional franchisees by McDonald’s.

However, real estate prices vary from region to region and it might not always make sense for McDonald’s to buy the land since the return on investment might not be good enough. In other cases, the real estate might demand too much investment. This is especially true in highly populated cities which are common throughout the developing countries.

The first few McDonald’s restaurants in developing markets usually flourish in the urban metropolitan cities where real estate prices can be several times those the average prices in the U.S. Sometimes, the rules are also carved out in a way such that they favor the tenants rather than the landlord. In such a scenario, McDonald’s lets the franchisees buy the land and develop restaurants and receives only the initial fees and royalty in return (i.e. no rent). Such franchisees are called developmental licensees. Figuring out the best policy takes time and can again decelerate the expansion process.

3) Capital expenditure

McDonald’s plans to spend $2.9 billion on capital expenditure in 2012, half of which will be spent to refurbish its existing restaurants in the U.S. and Europe to make them appear more upscale. As much as international expansion is important, the health of its restaurants in the U.S. and Europe cannot be overlooked since they contribute a lion’s share to its earnings (the two regions contribute almost 80% to the total profits). The U.S. has been the best performing market for McDonald’s this year with comparable sales up 4.8% in the first eight months.

Since McDonald’s has limited cash on its balance sheet, it has to carefully manage its expenditure between opening new restaurants versus upgrading existing ones. The company obviously does not want to invest so much that it puts a strain on its balance sheet without being absolutely sure of the returns.

4) Setting up the supply chain

The company has to spend a significant amount of time in setting up its supply chain before having a substantial presence in a region. In India, the fast food giant spent nearly $100 million working with farmers and setting up the supply chain six years before it officially opened its first restaurant in the country. Twenty years hence, the company has less than 250 restaurants in the country. Now, with the operations set up in the country and a firm grip on the understanding of the market, McDonald’s plans to double the number of restaurants in the country in three years beginning 2012.

In Russia too, McDonald’s will soon open its first restaurant in Siberia, a region in the Eastern part of the country. Until now, all of the 324 McDonald’s restaurants in Russia were present in the western region since the supply chain and logistical constraints did not allow the fast food chain to open outlets on the Eastern side. There was always scope to open new restaurants in Siberia since the region has only two other fast food chains, KFC and Subway, however setting up the supply chain often takes time.

5) Tailoring the right menu

McDonald’s has a presence in 120 countries. A long history of expanding into new territories has given McDonald’s the ability to mold its menu according to the tastes of the local population. Creating new menu products and developing a firm understanding of the local markets takes time. It would be foolish not just for McDonald’s but for any company to go full throttle with expansion without fully understanding the markets they operate in.

Recently, the restaurant chain even announced that it was going to open its first all vegetarian outlet in India. So, adjusting to the local conditions is a time-consuming effort and it is in McDonald’s best interests that it offers the right balance of local and international menu items before accelerating its store openings.

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